This adjustment to the filing window came with the Sarbanes-Oxley legislation. However, this concept is not perfect and there are ways that executives can take advantage of the way that options are granted in order to earn money. Is Backdating the New Corporate Scandal? Many companies' stock option plans provide that stock options must be granted at an exercise price no lower than fair market value on the date of the option grant. At one extreme, where it is clear that top management was guilty of conscious wrongdoing in backdating, attempted to conceal the backdating by falsifying documents, and where the backdating resulted in a substantial overstatement of the company's profitability, SEC enforcement actions and even criminal charges have resulted. See page 5 of the background briefing. In such a case, tax deductions would be denied. The problem with this practice, according to the SEC, was that stock option backdating, while difficult to prove, could be considered a criminal act. There is a five-year statute of limitations for securities fraud, and under the Sarbanes-Oxley Act of , option grants to senior management must be reported within two days of the grant date. Options backdating defeats the purpose of linking an executive's compensation to the company's performance, because the bearer of the options will already have experienced a gain. Sing or Keep Mum? Lin was accused of backdating stock option documents in order to give the appearance that options were granted on earlier dates than issued. Retrieved 11 December Initially, lax enforcement of the reporting rule was also blamed for allowing many companies to sidestep the rule adjustment that stemmed from Sarbanes-Oxley. Due to the implimentation of the Sarbanes-Oxley Act of , the rule has been changed and companies are now required to report the granting of options within two business days, which effectively has removed this loophole.
For example, the SEC filed a civil lawsuit in against Trident Microsystems and two former senior executives from the company for stock option backdating violations. The problem with this practice, according to the SEC, was that stock option backdating, while difficult to prove, could be considered a criminal act. Numerous financial analysts replicated and expanded upon the prior academic research, developing lists of companies whose stock price performance immediately after options grants to senior management the purported dates of which can be ascertained by inspecting a company's Form 4 filings, generally available online at the SEC's website was suspicious. Such backdating may be construed as illegally avoiding income recognition because falsely under-reporting the market price of such stocks makes them appear to have no value in excess of the strike price at the time the option is granted. Sing or Keep Mum? In some cases, backdating can be considered an act of fraud and an SEC investigation may result. In the past, granted options were only required to be disclosed to the Securities and Exchange Commission SEC within two months of the options being granted, which gives companies a window for backdating. The act of options backdating became much more difficult after companies were required to report the granting of options to the SEC within two business days. For instance, public companies generally grant stock options in accordance with a formal stock option plan approved by shareholders at an annual meeting. One of the larger backdating scandals occurred at Brocade Communications , a data storage company. In the modern business world, the Sarbanes-Oxley Act has all but eliminated fraudulent options backdating by requiring companies to report all options issuances within 2 days of the date of issue. Heinen for their alleged roles in backdating Apple options. Notable companies embroiled in the scandal include Broadcom Corp. The legal complaint alleged that from to , the former CEO and the former chief accounting officer directed the company to engage in schemes to provide undisclosed compensation to executives and certain employees. Annual and quarterly reports filed by the company did not include the compensation costs that stemmed from the options backdating incidents. Lin was accused of backdating stock option documents in order to give the appearance that options were granted on earlier dates than issued. Although many companies have been identified as having problems with backdating, the severity of the problem, and the consequences, fall along a broad spectrum. Initially, lax enforcement of the reporting rule was also blamed for allowing many companies to sidestep the rule adjustment that stemmed from Sarbanes-Oxley. See page 5 of the background briefing. Due to the implimentation of the Sarbanes-Oxley Act of , the rule has been changed and companies are now required to report the granting of options within two business days, which effectively has removed this loophole. Toward the other extreme, where the backdating was a result of overly informal internal procedures or even just delays in finalizing the paperwork documenting options grants, not intentional wrongdoing, there is likely to be no formal sanction—although the company may have to restate its financial statements to bring its accounting into compliance with applicable accounting rules. If a company backdated its stock options, but failed to recognize a compensation expense, then the company's accounting may not be correct, and its quarterly and annual financial reports to investors may be misleading. This is the granted option that would be reported to the SEC. However, this concept is not perfect and there are ways that executives can take advantage of the way that options are granted in order to earn money. The act of granting options with strike prices that are lower than the current market share price is technically legal, but the act of backdating the options may be in breach of the company's option plan, a shareholder -approved document that highlights the company's options policy.
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